The use of pre-packs or pre-positioned asset sales in Australia has traditionally been limited. This is a result of impediments to such transactions under the Australian legislative insolvency regime.
The interplay of these impeding factors means that there are few true pre-pack transactions in Australia. However, significant reform to the Australian insolvency regime is expected to be implemented in 2017. We wrote about the main aspects of that reform in our last article, `Australian insolvency law reforms aim to increase business restructuring opportunities'
There is a real question as to whether the soon-to-beimplemented reforms will have the effect of increasing the use of genuine pre-packs and if so, whether that is a good thing in light of experiences abroad, including in the United Kingdom where pre-packs have often been criticised for lacking transparency and prejudicing minority creditors and other stakeholders.
A pre-pack transaction is one in which the sale of all or part of a company's assets is arranged prior to, and completed shortly after, a formal insolvency appointment. A pre-pack transaction has elements common to phoenix activity because it involves the transfer of a distressed company's assets while creditors of the company remain unpaid. However, a genuine pre-pack is distinguishable by reason of the transaction involving commercial and arm's length consideration in exchange for the company's assets.
There have traditionally been significant impediments to conducting genuine pre-pack transactions in Australia. These vary in degrees but include:
- Australia's current insolvent trading laws - under the current legislative regime, a director attempting to restructure a company in financial distress can incur civil and even criminal liability for insolvent trading if the company continues to incur debts at a time when the company was insolvent.
- The prevalence of ipso facto clauses - ipso facto clauses allow a counterparty to terminate a contract if the contracting company is insolvent. The effect of such clauses is that valuable contracts may be terminated, significantly eroding the value of the business.
- Restrictions on insolvency practitioners - insolvency practitioners are required to demonstrate the requisite independence if they take an appointment to a company. This includes both actual independence and the perception of independence. Therefore, to the extent that an insolvency practitioner has had a pre-existing relationship with a company (for example, advising on a particular pre-pack transaction), there are limits on the practitioner taking a formal appointment. Additionally, an insolvency practitioner is under fairly rigorous restraints when selling assets of a company, including to take appropriate steps to obtain market value or, alternatively, to accept the best price possible for an asset. Such restraints may be common in other jurisdictions, but in Australia, in combination with other factors, they create a bias against pre-positioned sales.
- Directors' personal liability - in addition to possible personal liability for insolvent trading, directors face possible personal liability on a number of fronts, such as liability for certain unpaid taxes of a company and breach of director duties, including a duty to have regard to the interests of creditors when a company is insolvent or nearing insolvency.
The reforms proposed to Australia's insolvency regime go some way to ameliorating the impediments to genuine pre-pack sales.
Under the proposed reforms, directors will have some protection from Australia's draconian insolvent trading laws if they appoint a restructuring advisor to develop a turnaround plan for the company. This aims to enable directors to consider, formulate and implement pre-pack transactions, rather than prematurely appoint a voluntary administrator to avoid liability, even where the company may be financially viable in the long term. Providing a safe harbour to directors from insolvent trading laws will provide space for directors and insolvency practitioners to formulate and implement pre-pack transactions.
Further, under the proposed reforms, ipso facto clauses that allow a party to terminate a contract based solely on an insolvency event will be void. Therefore, contracts that previously could be terminated on insolvency will remain on foot. The continuation of such contracts preserves value and enables the company to give real consideration to a sale as a going concern, maximising any return to creditors.
The reforms therefore advance a legislative regime that preserves value and promotes a turnaround culture, which will no doubt see an increased use of more novel solutions for companies in distress involving the use of pre-packs. However, in a market that has traditionally been reluctant to explore the use of pre-pack transactions, especially where a related entity may be involved, the reforms are unlikely to result in a more systemic shift in the consideration and implementation of pre-packs in Australia.
While the reforms look set to enable greater consideration and implementation of pre-packs, the question remains whether that is a good thing, especially in light of experiences abroad. In the United Kingdom, pre-packs have faced criticism for lacking transparency and providing a potential vehicle to squeeze out junior creditors and disguise illegal phoenix activity.
While noting these concerns, the recent Graham Review found that the benefits of pre-pack transactions to the restructuring regime in the UK outweighed the perceived risks. Relying on the results of empirical research, the review found pre-packs to be cheaper and to stand a better chance of preserving jobs than traditional restructuring models, while deferred consideration under pre-packs was found to have a higher rate of repayment.
The Graham Review ultimately recommended promoting greater transparency of the pre-pack valuation and sale process, rather than restricting the scope for pre-packs altogether.
Any legislative insolvency regime needs to be flexible enough to ensure that whatever value remains in a company is preserved, whether by way of a pre-pack transaction or otherwise. While the proposed reforms to Australia's legislative insolvency regime go some way to removing impediments to value maximisation, they may not go far enough. It is yet to be seen whether the reforms, once implemented, will achieve their innovative aims and cause a cultural and practical shift in the way that value is maximised in respect of insolvent companies. An increase in the use of pre-packs in Australia which achieves a greater return on the business will be one measure of the proposed reform's success. Until such time as the reforms are implemented and if necessary extended to create more flexibility and remove more of the traditional impediments, the benefits of pre-packs that are available abroad will continue to elude the domestic market.